Since the crisis started seven years ago, each claim that the Eurozone’s recovery was imminent has been regularly disappointed. Latest projections of Eurostat show a stagnant outlook for the Eurozone, growth in the second quarter of 2014 was 0% compared to the previous quarter. This has triggered a downward revision for real GDP growth in 2014, now set by the ECB between 0,7-1% . Unemployment is around 12%, the highest level since the Euro club Member States fixed their exchange rates in 1997. According to some the Eurozone is performing worse than during the Great Depression of 1929.
So what is happening to the economy of the Eurozone? It helps to look at the situation at the aggregate level – the Euro area (EA) – as opposed to the performances of individual Member States. The reason is simple: by sharing a currency, Member States gave up monetary and – to a large extent – fiscal sovereignty. Two fundamental economic policy tools.
Thus we can take the US as a term of comparison, a federation of States with a centralised monetary as well as fiscal authority. After 2008, the US administration adopted a stimulus package loosening monetary policies and letting the Government deficit expand to counteract the private sector contraction. The FED (the US central bank) sharply reduced interest rates at an early stage and engaged in the active purchase of US Government Bonds for an amount that has now reached about 2 trillion dollars (helping to keep bond yields low). Finally, a system of fiscal transfers is in place in the US, both automatic and discretionary, to assist those States most hit by the recession. The amount of such transfers reached up to 50% of some States’ GDP.
In contrast the EA, after a brief fiscal expansion in 2009, enforced budget deficit consolidations across the currency union. Consequently its aggregate fiscal stance has been much more restrictive (see graph). The ECB reduced interest rates at a slower pace and actually even temporarily increased them in 2011. With the latest rates reduction, the ECB policy rate has reached now the level the FED has set since 2009. Moreover, by mandate, the ECB cannot directly purchase Governments’ bonds. Hence a market confidence crisis broke out in 2011 pushing bond yields upwards, adding additional strains to already fatigued public finances. Finally, the EA has no system of fiscal transfers in place to help Member States confronting mounting social costs.
These two markedly different policy responses explain the subsequent diverging evolution of output and employment in the two regions (see graph). Today eyes are once again on the ECB, expected by many to adopt unconventional policies such as the Quantitative Easing. But as the ECB President made clear a few weeks ago, monetary policies alone cannot revive depressed aggregate demand, appropriate expansionary fiscal policies are also needed. Enabling the EA institutions to effectively respond to such needs will have to be a priority of the new Commission and Council, if growth and jobs are to be restored.